Diversification is capable of building shareholder value if it passes three tests:
1. Industry attractiveness test
2. Cost of entry test
3. Better off test
With the aid of practical examples from any organization(s) of your choice, explain to your CEO the
strategic implications of the above three tests. [50 marks]
A common thing facing almost all businesses is competition. Businesses therefore need to
comprehend and efficiently analyse their competitive environment in order to survive the
competition in their respective industries. Corporates can employ various strategic tools such as
SWOT analyses and Porter’s Five Forces to comprehend and appreciate the significance of the
competitive environment. The Indeed Canada Corporation (2022) asserts that the competitive
environment is where different businesses compete by using various promotional strategies,
marketing channels and pricing methods within a defined marketplace. It involves how a business is
affected by competition and how it adjusts its strategies to compete effectively. This leads some
companies to consider diversifying.
Diversification is a risk management technique of allocating portfolio resources or capital to a mix of
different investments. The ultimate goal of diversification is to minimise losses by investing in
different areas that would each react differently to the same event, (Lioudis, Potters and Jackson,
2022). A phrase commonly associated with diversification: “Do not put all your eggs in one basket.”
Having “eggs” in multiple baskets mitigates risk; if one basket breaks, not all eggs are lost.
Companies using diversification strategies enter completely new industries.
There are three types of diversification which are concentric, horizontal and conglomerate. In the
concentric strategy, the company adds new products or services which have technological or
commercial synergies with current products and which will appeal to new customer groups (Machel,
1972). In the horizontal diversification there is production of new products and services that do not
refer to the current business activity but are offered to the current customer (Ticha & Hron 2007). In
the conglomerate (mixed) diversification, the organization produces new products and services that
do not refer to the current business (Ticha & Hron 2007).
To ensure that a company’s diversification strategy will create long-term shareholder value, Michael
Porter developed three tests which need to be fully satisfied.
The three tests are shown by the image below:
1. Industry attractiveness test
The industry attractiveness test aims to ensure that diversification is directed towards an attractive
industry. It is regarded as the means of determining if the new market is appealing for the company
to enter in the first place. Lucidity (2023) posits that the instrument can be positioned as a critical
component of the provisions for entering a specific market or business area since it points to the
chances for growth that a firm may enjoy.
The attractiveness test is a key test when making diversification decisions because it is imperative for
firms to determine whether the opportunity is capable of generating value for the business. This
value can be achieved if the new market being entered is capable of generating revenues greater
than the cost of entering, (Lucidity, 2023).
Diversification into a market or industry that is tedious, whether because of general economic
circumstances or local problems, can result in a substantial loss of income and security. As Mintzberg
and Quinn (1992) observed, some businesses attach little significance to this, relying instead on
vague beliefs that the industry or market is a good fit with its existing operations. Other businesses
ignore the attractiveness test due to low entry cost. Sometimes the buyer has an inside track or the
owner is anxious to sell. Even with a low price, a one-shot gain will not offset a perpetually poor
business. Besides, some businesses mistakenly interpret recent market or industry trends as
indications of long-term health (Mintzberg and Quinn (1992). Examples of companies that entered
unattractive industries and were successful because their business model was strong in other areas
include: Apple (computer hardware), Nike (shoes), Waste management (garbage) and Vistaprint
(commercial printing). Yes, but cite specific practical examples!!!!
The dimensions of market attractiveness include market size or potential (Brewer, 2001;
Papadopoulos et al., 2002) and market development (Day et al., 1988). Market size or potential has
to do with the size of the market and the amount of sales, profits, etc. that can be obtained from
entry and throughout the presence of companies in that market or in a planning period (Sakarya et
al., 2007). Market development captures the quality of the market in terms of its socio-economic
advancement or progress. Aspects such as per capita income and employment rates are believed to
reflect levels of market development. Managers can use industry and product specific criteria to
operationalize both dimensions (market size or potential and market development) and readily
identify the specific attractiveness of markets related to their businesses. Yes, but cite specific
practical examples!!!!
Porter’s Five Forces can be used to help determine if the industry structure is desirable for a
company, which explains the profitability of the industry as depending on the power of the buyers,
suppliers, threat of substitutes, industry rivalry, and the threat of entrants. If the industry is not
attractive, the opportunity may not be desirable for the company to pursue.
Industry rivalry
Competitive rivalry evaluates how intense competition is in the market. It is the principal
determinant of competitiveness and profitability. Beacon Mergers and Acquisitions (2021) elucidate
that industries where competition is intense can often have lower profitability. In a competitive
industry, businesses must compete aggressively for market share. This determines the attractiveness
of the industry because industries with lower competition are more attractive than competitive
industries because they are riskier.
For example, in November 2013 Lenovo diversified into manufacturing phones in at least 20 new
markets and in 2016 it suffered because it did not have a strong branding, this is because it did not
conduct a proper industrial rival analysis. The level of competition among the major companies that
competed directly with Lenovo in the technology sector is high. Lenovo was in direct competition
with companies such as Samsung Electronics Co Ltd., and Apple Inc. All of these companies expend
substantial capital on research and development and marketing. Hence, the competitive force within
the industry is strong. One thing that makes the industry so highly competitive is the relatively low
switching cost. It does not require a substantial investment for a consumer to ditch Apple's mobiles
for a Samsung or other tablets. The threat of the marketplace competition was a key consideration
for Lenovo, which it has dealt with primarily through continually developing new and unique
products to increase and strengthen its market share position. Yes, but cite specific practical
examples!!!!
The key factors that our organisation should consider before diversification that are typically
associated with industrial rivalry are as follows:
•
The number of competitors in the targeted industry.
•
Cost of industry exit.
•
Industry growth rate and size.
•
Product unique differentiation.
•
Competitors size and capital.
•
Customer loyalty.
•
The threat of horizontal integration.
•
Level of advertising expense.
BBK Electronics Corporation diversified into the telecommunications in 2004 to produce OPPO
mobiles and it have gained a 5.37% market share in the competitive market, our organisation can
use the OPPO strategy to beat competition.
Bargaining power of buyers
The power of buyers examines the impact that consumers possess and its effect on pricing and
quality, which has a large effect on industry profitability (Beacon Mergers and Acquisitions (2021). If
buyers have a lot of power, they have the ability to set the price because usually there are very few
buyers and many suppliers (N. Saint, 2013). In this regard they can collectively drive down prices
and lower industry profitability. For instance, buyer power is high in the food retail industry.
Customers have easy access to price checking among a large variety of different grocery stores.
Moreover, switching costs between different competitors within the food retail industry are
negligible, and price-conscious consumers enjoy a high degree of sovereignty.
Another example is when Apple Inc diversified to smart-audio and smart watches, they discovered
that individual bargaining power is a weak force, since the loss of any one customer represents a
negligible amount of revenue for Apple (investopedia.com). However, the collective marketplace
bargaining power of customers, the possibility of mass customer defections to a competitor is a
strong force. Apple counters this strong force by continuing to make substantial capital expenditures
in R&D, enabling it to keep developing new and unique products such as the Airpods and the Apple
Watch, and by building significant brand loyalty. Apple has been very successful in this area of
competition, establishing a large customer base that, basically, would not consider abandoning its
iPhones in favour of another smartphone competitor. However, the threat to buyers is not a big
concern to Apple Inc. The competition on this area falls on the pricing system and differentiation of
products to meet the unique needs of the consumers. The move to differentiate the products of the
company is aimed at addressing the diverse needs of the consumers (B-Kareborn, 2013). Also,
buyers know what they are getting before they even think about buying it, there is less bargaining if
our organisation diversify into a telecommunication industry. Yes, but cite specific practical
examples!!!!
The key factors that our organisation should consider before diversification that are typically
associated with bargaining power of buyer are as follows:
•
Buyer size and capital.
•
Cost of switching suppliers.
•
Current and potential buyers.
•
Order and wallet size.
•
Potential and real product substitutes.
•
Price sensitivity.
•
The threat of integrating backward.
Yes, but cite specific practical examples!!!!
The threat of new entry
The threat of new entry determines how easy (or not) it is to enter a targeted industry. It examines
the barriers to entry of an industry. The higher the barriers are, the less threat there is to existing
entrants; if barriers to entry are lower, it will be easier for new competitors to enter the market,
threatening the business of existing competitors (Beacon Mergers and Acquisitions, 2021). If an
industry is viewed as profitable with few barriers to enter, competition soon strengthens. When
more businesses compete for the same market share, profits will ultimately decrease. It is missioncritical for existing industry participants to create high barriers for entry to deter new entrants.
For example, Lenovo’s analysis before the launch of their smartphones should have deterred that
any new entrant to the marketplace of personal computing or smartphones needs to have a massive
amount of capital just to spend on R&D. Also, manufacturing to develop and produce its own
product portfolio prior to ever bringing its products to market and beginning to generate revenue.
Lenovo faced the already identified strong competition within the industry that exists between
Apple and its major competitors, all of which are large, well-established firms. Nonetheless, Lenovo
should have continued strengthening its competitive position through new product development
and building brand loyalty to survive in the industry. BBK Electronics Corporation insisted on a
consumer-oriented strategy and tried to explore the demand of consumers and increase consumers’
experience, thus it survived in this industry. Yes, but cite specific practical examples with sources!!!!
The key factors that our organisation should consider before diversification that are typically
associated with threat of new entry are as follows:
•
Access to suppliers and distributors.
•
Brand reputation.
•
Capital required.
•
Economies of scale.
•
Government regulation.
•
Legal barriers.
•
Product unique differentiation.
•
Retaliation by current industry businesses.
•
Infrastructure costs.
Yes, but cite specific practical examples with sources!!!!
Bargaining power of suppliers
The bargaining power of suppliers examines a supplier’s ability to control pricing. Similar to buyer
power, supplier power has an inverse relationship with industry profitability as it has the potential to
raise costs. The more power the supplier has, the higher the input costs for target industries. It
allows suppliers to sell higher priced or low-quality raw materials to corporate buyers. This hinders
industry attractiveness if the bargaining power of supplier is high. Our organisation should diversify
into an industry were the bargaining power of suppliers is low.
For example, supplier power in the chip manufacturing industry (Simba, Lays, Doritos) is extremely
high as one chip manufacturing company accounts for over fifty percent of the global chip supply.
Consequently, the high dependence on this particular supplier due to bottlenecks in supply
chain and the high degree of product differentiation, leads to a lack of available substitutes which
gives suppliers in this industry a high degree of power.
Also, as an example, the bargaining power of suppliers is a relatively weak force in the marketplace
for Apple's products. The bargaining position of suppliers is weakened by the high number of
potential suppliers for Apple and the ample amount of supply. Apple is free to choose from among a
large number of potential suppliers for component parts for its products. The industries of its parts
suppliers, such as the manufacturers of computer processors, are themselves highly competitive.
Yes, but cite specific practical examples with sources!!!!
The switching cost for Apple to exchange one supplier for another is relatively low and not a
significant obstacle. Apple is a major customer for most of its parts suppliers, and, therefore, its
suppliers are very reluctant to risk losing the company's business. This strengthens Apple's position
in negotiating with suppliers, while conversely weakening their positions. The bargaining power of
component parts suppliers is not a major consideration for either Apple or its major competitors
(investopedia.com). In this industry suppliers have low bargaining power and they provide quality
goods this industry is attractive. Also, National Foods Ltd used to be the biggest flour producer and
had a high bargaining power in the manufacturing industry, they charged higher prices and usually
provided flour of low quality which affected the type of bread manufactured in Zimbabwe in 2021.
Yes, but cite specific practical examples with sources!!!!
The key factors that our organisation should consider before diversification that are typically
associated with bargaining power of suppliers are as follows:
•
Ability to source substitute materials.
•
Switch cost to alternative product materials.
•
Materials scarcity.
•
Suppliers in the targeted industry.
•
Suppliers size and capital.
•
The threat of integrating forward.
Threat of substitutes
The force of threat of substitutes examines the ease of consumers switching from a business’
product or service to that of a competitor. The more products that exist that may be different but
serve the same purpose as the original product, the higher the likelihood of customers switching to
alternatives. Substitutes do not have to necessarily be similar to the original product and only be
branded differently; substitutes can be products that serve the same purpose for the consumer as
the original product. Substitutes can create a cap on the prices that buyers will pay and a floor on
the prices that suppliers will require. Substitutes can take business from companies within the
industry and thus lower profitability.
An example of a substitute for printed books is Kindle e-books. These products are different where
printed books can be physically handled whereas Kindle e-books need to be accessed using an
electronic device, such as a Kindle e-reader or on a Kindle mobile app. Although these products are
not solely similar products marketed differently like Pepsi and Coca-Cola, they still serve the same
purpose, being reading content. Kindle e-books are a threat to printed books since they are
substantially priced lower than printed books as they require no raw material to produce.
2. Cost of Entry Test
The Cost of Entry Test ensures that the cost of entry does not capitalise all future profits. It evaluates
if the potential profitability of the market is greater or lower than the cost of entering as postulated
by Lucidity (2023). If it’s lower, then you shouldn’t be looking to enter the market. This test requires
some research into your new market in order to establish all the costs you would incur from
operating the new venture. Consider the existing competitors, who already have scale and
experience, and how much you’d spend when you compete against them. If you’re unsure then a
MVP or proof of concept test might be a way to minimise the cost of entry while gathering enough
feedback to decide if it’s worth aggressively going for the new market. Yes, but cite sources and
specific practical examples with sources!!!!
Companies can enter new industries by acquisition or start-up. An acquirer can beat the efficient
merger market if it pays a price below the price that fully reflects the value of the new unit.
However, this is difficult when multiple bidders are common place and information flows rapidly
through investment bankers and intermediaries. Start-ups, on the other hand must overcome entry
barriers that tend to be high for entry into attractive industries. Yes, but cite sources and specific
practical examples with sources!!!!
The cost to enter the target industry must not be so high as to exceed the potential for good
profitability. The more attractive an industry’s prospects are for growth and good long–term
profitability, the more expensive it can be to enter. And buying a well-positioned company in an
appealing industry often entails a high acquisition cost that makes passing the cost-of-entry test less
likely. Since the owners of a successful and growing company usually demand a price that reflects
their business’s profit prospects, it’s easy for such an acquisition to fail the cost-of entry test Yes, but
cite sources and specific practical examples with sources!!!!
Company executives should consider the following reflections about cost of entry:

You could acquire a business or unit rather than create a new product or service

You should be using other tools such as Five Forces in an attempt to understand the market
Make sure you evaluate competitor activity from their team sizes (use LinkedIn) to their published
accounts and news Yes, but cite sources and specific practical examples with sources!!!!
Diversification is a form of growth marketing strategy for an organization and seeks to increase
profitability through greater sales volume obtained from new products and new markets. Wan and
Hoskisson (2003) and Wan (2005) posit that high levels of diversification improve firm performance
even when a country’s institutional environment is inadequately developed. This helps executives in
justifying diversification decisions. Yes, but cite specific practical examples with sources!!!!
Diversification depends on the financial health of a firm. Business owners should undertake a
comprehensive review of their present fiscal standing and future prospects before expanding a
business into a new area (Steven and Marks 1998). The cost of entry into a market should be
considered before the diversification process start.
Diversification, whether through diversification or acquisition, typically requires financial outlays of
significant size. A company must have the means to meet new financial requirements while
simultaneously keeping the existing business running smoothly (Steven and Marks 1998). The need
for external finance can improve the allocation of capital even in instances in which it introduces
inefficiencies at the firm level (Almeida & Wolfenzon, 2004). Yes, but cite specific practical examples
with sources!!!!
In the presence of limited pledge ability, outside investors prefer to liquidate a mediocre project
because they can only get a fraction of the future return. However, in the absence of external
finance, insiders prefer not to liquidate such projects because they keep the full return. For a firm to
attract more often than internally financed firms (Diamond, 1991). While excessive liquidation might
be suboptimal for a firm in isolation, it may be socially beneficial because the released capital flows
from mediocre to high productivity projects and thereby improves capital allocation. Yes, but cite
sources and specific practical examples with sources!!!!
Diversification requires carefully thought out decisions. This is because according to the
https://hbr.org/1997/11/to-diversify-or-not-to-diversify the diversification misadventures of a
number of oil companies in the late 1970s highlight how dangerous it is to go up against a royal flush
when all you have is a pair of jacks. Companies such as British Petroleum and Exxon broke into the
mineral business they could exploit their competencies in exploration, extraction, and management
of large-scale projects. Ten years later, the companies had dropped out of the game. The reason
being that in addition to the oil companies’ capabilities, the mineral business required low-cost
extraction capabilities and access to deposits, which the oil companies lacked. Yes, but cite specific
practical examples with sources!!!!
The https://hbr.org/1997/11/to-diversify-or-not-to-diversify website explains the experience of the
Coca-Cola Company, long heralded for its intimate knowledge of consumers, its marketing and
branding expertise, and its superior distribution capabilities. Based on those strategic assets, CocaCola decided in the early 1980s to acquire its way into the wine business, in which such strengths
were imperative. The company quickly learned, however, that it lacked a critical competence:
knowledge of the wine business. Having 90% of what it took to succeed in the new industry was not
enough for Coke, because the 10% it did not have—the ability to make quality wine—was the most
critical component of success. Yes, but cite specific practical examples with sources!!!!
Entering new markets in related areas and exiting declining markets is critical for organisational
survival and growth, according to authors Helfat and Eisenhardt (2004), who urge us to revisit the
benefits of related diversification by taking a dynamic perspective. The traditional rationale for the
diversified company is that related businesses within the same firm can share resources and, as a
result, the total costs of producing all the various products offered by the company is lower than
that of producing them separately. Yes, but cite specific practical examples with sources!!!!
3. Better off Test
The Better off Test looks to establish if the company or new unit will be better off from the
diversification and thus gain some form of competitive advantage. In order to pass the test, there
has to be some tangible benefit to either the existing company, acquired company, or new business
unit. Yes, but cite sources and specific practical examples!!!!
The benefit could come in many forms, such as increased capabilities or access to new market
channels, but to be successful in the long term this has to be in place. Diversification has not only
been one of the main topics of interest within strategic management research, but has also received
the attention of historians, economists and researchers in such areas as finance, law, marketing and
public policy (Hoskisson and Hitt, 1990; Ramanujam and Varadarajan, 1989). Yes, specific practical
examples!!!!
Diversification can be defined as the entry of a company into new lines of activity through a process
of internal development or through acquisition, which entails changes in its administrative structure,
system or other management procedures. Within this definition is implicit the assumption that the
decision of the company to enter a new business is linked to the choice of the entry mode into that
business. Yes, but cite sources and specific practical examples with sources!!!!
Diversification can offer companies many advantages. From a financial point of view, they include
cost reduction, asset depreciation and risk reduction (Bergh, 1997). Strategic advantages involve
synergies or the expansion, creation and improvement of long-term strategic assets (Li and
Greenwood, 2004; Markides and Williamson, 1994). These advantages are particularly evident in the
tourism sector: synergies, cost sharing, risk reduction or brand improvement. In addition, resource
diversification contributes to long-term sustainability and regional development (Ivars, 2003). Yes,
specific practical examples with sources!!!!
The main purpose of diversification is to allow an organisation to grow (Grant, 2005; Thomas and
Mason, 2006). Diversification strategically takes the organisation away from its current markets and
products with the overall intention to increase the diversity that must be overseen by the
organization.
International Business Machines (IBM) provides a good example of an organization that has pursued
diversification in a purposeful and vigorous manner (Strategic Direction, 2005). Up until the 1980s,
IBM enjoyed a virtual monopoly in hardware but this changed very rapidly with increased
competition. Diversity in all its implications became the central driver for IBM from 1995 onwards.
Diversification included both reviewing the inputs (with the diversification of the workforce) and the
outputs (with the move away from products towards services and solutions). One of the main
advantages of diversification identified in the management literature is the synergy that it creates
(Ensign, 1998). By moving into new areas, opportunities emerge to develop new inter-relationships
through the actual process of working on new services and markets. This synergy makes it is possible
to produce a combined return on resources that is greater than the sum of the parts. The likely
success of the diversification strategy will be the fit between the different business units and their
working relationships. The impetus is on the managers of the different units to understand their
inter-relationships so the probability of synergy can be increased. Yes, but cite specific practical
examples with sources!!!!
According to Calori and Harvatopoulos (1988), there are two dimensions of rationale for
diversification. First, the diversification may be defensive or offensive. Defensive reasons may be
spreading the risk of market contraction, or being forced to expand when current product or current
market orientation seems to provide no further opportunities for growth. Offensive reasons may be
conquering new positions, taking opportunities that promise greater profitability than diversification
opportunities, or using retained cash that exceeds total diversification needs. The second dimension
involves the expected outcomes of diversification. Yes, but specific practical examples with
sources!!!!
Management may expect great economic value (growth, profitability) or first and foremost great
coherence and complementarities with their current activities (exploitation of know-how, more
efficient use of available resources and capacities). In addition, companies may also explore
diversification just to get a valuable comparison between this strategy and diversification
The https://hbr.org/1997/11/to-diversify-or-not-to-diversify website explains that as in poker, the
lesson for companies considering diversification is the same: You have to know when to hold them
and when to fold them. If a company is holding only a pair of strategic assets in an industry in which
most players have a better hand, there’s no point in putting money on the table—unless, that is, the
next question can be answered in the affirmative. Yes, but cite sources and specific practical
examples with sources!!!!
Some considerations for the Better Off Test:

Benefits should be ongoing rather than one off

Look across your business operations to evaluate each one against the diversification

Ensure you have the right skills in the business to implement the wins of diversification

Evaluate the Better Off test after diversification has happened to ensure you are achieving
all the benefits
Consider the diversification history of Sharp Corporation. In the early 1950s, the company decided to
leverage its existing strengths in the manufacturing and retailing of radios by moving first into
televisions and then into microwave ovens. Sharp licensed the television technology from RCA and
acquired the microwave oven technology by working with Litton, the U.S. innovator in that
technology. Similarly, Sharp diversified into the electronic calculator business in the 1960s by buying
the necessary technology from Rockwell. In 1969, Sharp invested $21 million—about one-quarter of
the company’s equity at the time—to build a large-scale-integrated-circuit factory and a central R&D
lab to facilitate entry into the semiconductor business. In the 1990s, it has made even bigger
investments in order to bring the company up to speed in the liquid-crystal-display industry.
Between 1990 and 1992 alone, Sharp invested $540 million in liquid-crystal-display factories and
earmarked an additional $550 million for future investments. These investments left the company
better off and executives may learn from this experience. Yes, but cite sources for examples cited!!!!
The Walt Disney Company has diversified following a similar strategy, expanding from its core
animation business into theme parks, live entertainment, cruise lines, resorts, planned residential
communities, TV broadcasting, and retailing by buying or developing the strategic assets it needed
along the way. For example, Disney’s cross-promotional relationships with McDonald’s and Mattel
gave it an edge in retailing, and its close working relationship with the Florida state government gave
the company the expertise it needed in the theme park business. Yes, but cite sources for the
specific practical examples!!!
One case in point is Canon, which wanted to diversify from its core business of cameras into
photocopiers in the early 1960s. Canon boasted strong competencies in photographic technology
and dealer management. But it faced formidable competition from Xerox, which dominated the
high-speed-copier market, targeting large businesses through its well-connected direct sales force.
In addition, Xerox leased rather than sold its machines—a strategic choice that had worked well for
the company in its earlier battles with IBM, Kodak, and 3M. Yes, but cite sources for the specific
practical examples!!!!
After studying the industry, Canon decided to play the game differently: The company targeted small
and midsize businesses, as well as the consumer market. Then it sold its machines outright through a
network of dealers rather than through a direct sales force, and it further differentiated its products
from those of Xerox by focusing on quality and price rather than speed. As a result, whereas IBM and
Kodak failed to make any significant inroads into photocopiers, Canon emerged as the market leader
(in unit sales) within 20 years of entering the business. It was, however, a radically different business
because of the way Canon had transformed it. Yes, but cite sources for the specific practical
examples!!!!
The above scenarios highlight that the companies concerned became better after diversification and
company executives may also research and build from this case study.
Conclusion
Not all companies have the skill, financial strength, and managerial foresight to pull off what Canon
did. But, together with Sharp and Disney, Canon provides an excellent example for companies
considering diversification. Those assets must be obtained one way or another; otherwise, moving
forward into new markets is likely to backfire.
Diversification as a strategy has positive or and negative results. A modest amount of related
diversification may well be desirable, particularly for companies in mature industries. Here,
diversification is itself, many will argue, a form of organisational innovation and in the long term
essential for organisational growth and survival.
Economies of scope can be still a powerful source of competitive advantage, especially for
companies that have established successful brands with high levels of customer loyalty and frequent
customer contact, like Virgin or Tesco.
In addition, there are also consumption economies of scale, particularly in the IT industry. Here,
customers often prefer to purchase and use families of products which have the same look and feel,
explaining the strategies of companies like Microsoft and Google. Some diversification, such as that
engaged in by the automobile manufacturers mentioned above, is a consequence of the core
business becoming ‘commoditised.’ Firms thus diversify from producing and selling products to
‘bundling’ related services to increase margins. While this type of diversification can be difficult
because the skill sets are very different, the move from products to systems may be a legitimate
diversification path in these types of circumstance.
Porter’s Three Tests work well when used in conjunction with other frameworks. Porter’s Five
Forces or the Six Forces model are a great way to establish attractiveness by looking at the dynamics
within the potential market, whilst the Ansoff Matrix is a commonly used tool when looking at
diversification in general.
Porter’s Three Tests has some advantages that management and company executives should be
aware of when making diversification decisions. The advantages to using Porter’s Three Tests
include:

A higher chance of diversification success

They are simple tests to challenge thinking

They can be split up and allocated to specialists on the team

They are mutually exclusive and if done sequentially can save time on ideas that won’t work
Despite the advantages listed above, Porter’s Three Tests disadvantages that management and
company executives should be aware of when making diversification decisions. Some disadvantages
to the Porter’s Three Tests include:

It requires other frameworks to evaluate the marketplace

It is subjective to answer some of the questions

There is an element of ambiguity in two of the three tests
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